Although the red-hot agency acquisitions market has slowed because of shriveling capital and a dwindling pool of candidates, smart buyers and sellers can still work a profitable deal if it's a strategic fit and the transaction is well planned, experts say.

A panel of experts representing agencies, insurers and investors discussed M&A trends and how to strike a successful deal at the Eighth Annual Summit Meeting of the Target Market Program Administrators Association last month in Tempe, Ariz.

Although the number of completed deals declined 10 percent since 2007, there is more interest than ever in M&A activity, according to Kevin Donoghue, managing director of Mystic Capital Advisors Group LLC in New York and panel moderator.

“There's never a right or wrong time to do a deal,” said Art Seifert, president of U.S. Risk Underwriters, a Dallas wholesaler–who added, however, there will be many variables, including the seller's age and how much they want to work in the future.

Mr. Seifert started a program company from scratch, then borrowed capital from a carrier to buy out his partners. He subsequently sold to U.S. Risk Underwriters and now runs the division as Lighthouse Underwriters and The Lighthouse Companies. “No deal will ever end up looking like the way it was first presented,” he said.

Representing private equity, Chris Lalonde, a principal at Century Capital Management in Boston, said that in spite of the economic crisis, deals are still getting done. He added, however, that “big deals are frozen because if you went to the investment bank for debt, they're not lending,” noting that as a result, the timeframe for securing debt for a deal has increased.

Much of Century Capital's debt comes from traditional banks–another frozen source–but with the $700 billion government bailout in the wings as he spoke, Mr. Lalonde said he believes these sources should be loosening up soon. Companies and large pension funds are also looking for good places to invest, he noted.

Panelists also discussed the qualities that attract buyers and sellers.

William Kronenberg, chairman of Professional Underwriters Corp. in Exton, Pa., said buyers primarily seek underwriting expertise, which is critical to carriers, followed by program profitability within the book of business and a good cultural fit. The last element is essential when merging two or more entities, he added.

Mr. Kronenberg spent the first 10 years of his career with American International Group working with managing general agencies, where he learned firsthand what insurers look for in an acquisition. He later worked at an employee-owned agency specializing in environmental coverage, which was later bought out by the firm, using bank financing.

That company became XL Environmental Inc., which was sold to XL Capital. Four years ago, Mr. Kronenberg bought Professional Underwriters, which specializes in schools and municipalities, using Zurich and AIG as underwriting partners.

Like Mr. Kronenberg, Mr. Seifert agreed that “a poor cultural match is frequently why a deal doesn't work.” Thus, the people involved in the deal are vitally important, especially if the principals will be staying with the business, he said. It's also important to understand business processing from a technology standpoint and to be able to merge two different systems, he added.

Speaking from an insurer's perspective, David Jordan, senior vice president of AIG, said company buyers seek “intellectual capital of the entire organization, not just the principals.”

Business sustainability, margin improvement and underwriting profit are also essential, according to Mr. Jordan, who is chief operating officer of Risk Specialists Companies, a surplus lines broker subsidiary of AIG that produces and underwrites business for AIG entities including Lexington Insurance Company.

Mr. Lalonde said “the management team is key” for private equity firms, “because we don't go in and run the business for you.” Century Capital is also attracted to businesses with competitive market advantages, such as great technology, as well as a high-quality distribution system, underwriting expertise and a stellar reputation within the industry.

When deals go bad, panelists agreed that a lack of knowledge about the acquired or acquiring organization is typically to blame.

“If you're an MGA selling to a carrier, you've got to understand the actuarial end of the business because that's what's important to the carrier,” Mr. Kronenberg said.

In the past, it was rare for a carrier to buy an MGA, but over the past two or three years, it's been a growing trend, he noted. He believes this is a good trend for the business because it is an indication program administrators are now working toward the same goal as carriers. “We have raised our game closer to their level,” he said.

Mr. Jordan said that when insurers acquire MGAs, it's frequently a defensive move to squelch a competitor, adding that buyers are shifting from domestic carriers to players from London or Bermuda.

“Our view is colored by underwriting results and projections, which are very important to us,” he said, adding that deals that didn't work out usually failed because of a poor cultural fit.

Problems can also arise if a transaction changes the original business's distribution system, according to Archie McIntyre, senior vice president of business development for Southfield, Mich.-based Meadowbrook Insurance Group. “Distribution is the lifeblood of the business, so it must be clear when acquiring a company how this will be handled,” he said.

Mr. McIntyre has spent 20 years at Meadowbrook, which started as a privately owned agency that evolved into program business. Meadowbrook recently completed three transactions, acquiring program administrators and ProCentury Corp., an excess and surplus lines insurer, in a $270 million deal.

Mr. Seifert said an acquired business that is converted into a product portfolio will change distribution and, ultimately, earnout–”the trickiest part of the deal,” referring to variable future payments based on premium, net revenue or earnings.

Earnout can also be affected if a business loses good program managers in the process of being sold, he said.

Another recipe for failure is relying too heavily on bank financing to the point the bank is calling the shots, according to Mr. Seifert. “Bank financing can be cheap, but there are usually strings attached to that cheap money,” he said. “The market cycle affects earnings and thus earnout. You could end up running a business to please the bank.”

The panelists were divided on the wisdom of program administrators owning or creating carriers or captives.

Mr. Kronenberg's firm created an offshore reinsurer years ago, but the regulatory climate was less restrictive at the time, he noted. “For the average program administrator in a tough credit market, this isn't a good idea, because it's hard to raise the money needed to start up,” he said. “You're also committing that the money will be there, which totally changes the game.”

Increased responsibility on filings and regulations makes such an undertaking extremely labor intensive, he said, adding that “being a carrier is very different than being an MGA. It's a big boy's game.”

Mr. McIntyre said Meadowbrook formed an admitted carrier in 1986, which subsequently went public. “But it's a long horizon. The idea must be very well thought out,” he said.

“Some program administrators run captives, but I would generally discourage it,” he added.

At this point, Risk Specialists Companies would probably not be interested in acquiring a program administrator that was in the risk-bearing business, according to Mr. Jordan, who said capital and regulatory requirements are intense, and risk bearing would be a deal deterrent.

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